Author(s): James R. Walker
Published: 10/10/2008
On Saturday, August 18, 2008, Pastor Rick Warren of the Saddleback Church served as moderator of the Saddleback Civil Forum on the Presidency. The forum was widely viewed and shown live on at least two cable television networks. As moderator, Pastor Warren questioned both Senator Obama and Senator McCain and provided each presidential candidate with an early opportunity to present his case.
With his very public role and with the success of his best-selling book, The Purpose Driven Life, Pastor Rick Warren has emerged as a prominent evangelical religious leader shaping the "national debate." But even before his success as an author and before the Saddleback Forum, Pastor Warren helped shape our federal income tax law.
Pastor Warren’s involvement with the federal tax law centered on the long-standing tax exemption known as the "parsonage allowance." Having first appeared in 1921, the exemption is broadly construed, covering church-provided parsonages, "rental allowances" that a minister uses to rent a home, and "housing allowances" that a minister uses to purchase a home.
The IRS Audit Program and Pastor Warren
Even though the parsonage is omitted from a minister’s tax return, the parsonage allowance has not escaped IRS scrutiny. Several years ago the Internal Revenue Service created a "specialization program" designed to educate IRS agents on auditing clergy tax returns. This audit program led to an income tax audit of Pastor Warren’s tax return.
Pastor Warren’s Parsonage Payments
Pastor Warren’s audit involved the scope of the parsonage exemption and his housing allowance. Shortly after founding Saddleback, Pastor Warren purchased a home. Over the next three years, Saddleback paid Pastor Warren a parsonage allowance that he used to pay his mortgage, utilities, furnishings, landscaping, repairs, maintenance, taxes, and insurance. Saddleback designated the payments as a parsonage allowance and excluded these payments from Pastor Warren’s income.
At the conclusion of his audit, the IRS determined that a portion of these payments must be taxed. The IRS theorized that Pastor Warren’s parsonage exemption could not exceed the home’s fair market rental value. In other words, Pastor Warren must be taxed to the extent the housing allowance payments exceeded his home’s fair market rental value.
Pastor Warren contested the audit results in the United States Tax Court. In May 2000, the Tax Court sided with Pastor Warren, holding that Congress did not create a fair market value limitation for parsonage allowances. The Tax Court ruled that the exemption’s only condition or limitation was that the payment actually be used to provide a home. Since Pastor Warren used the payments to pay his mortgage and improve the residence, the Tax Court supported the exemption.
The Ninth Circuit and the Latent Constitutional Issue
The federal government was not content with Pastor Warren’s success in the Tax Court. The Justice Department appealed his case to the Ninth Circuit, asserting that the parsonage exemption could not exceed a residence’s fair rental value. In other words, the government framed the issue solely as a matter of statutory construction: whether a clergyman receiving a cash housing allowance can exclude the full amount of the allowance spent on housing or whether Congress capped the exemption at a home’s rental value.
But in examining the government’s appeal, the Ninth Circuit took a sharp detour. It shunned the tax issue and invited the parties to frame the issue in constitutional terms. Both the IRS and Pastor Warren declined, but the Ninth Circuit persisted. It ordered the parties to address whether the parsonage exemption passes constitutional muster. The Ninth Circuit panel also appointed a law professor to brief the constitutional issues.
Faced with the possible loss of the entire parsonage tax exemption on constitutional grounds, many religious leaders participated in an effort to craft a legislative solution. This effort call encouraged Congress to pass the Clergy Housing Allowance Clarification Act of 2002.
President Bush signed this act on May 20, 2002. With this change Congress capped the parsonage exemption at the amount of a home’s fair rental value. Thus, the maximum parsonage exemption is a home’s rental value, including furnishings and appurtenances such as a garage, plus the cost of utilities. The cap applies to the 2002 tax year and years following.
Several years ago, Pastor Warren’s tax case served as a wake-up call. Like Pastor Warren, clergy must be prepared to defend the amount of their parsonage. For parsonages paid as housing allowances, this defense will include evidence that the amount paid does not exceed a home’s fair rental value.
Rothgerber Johnson & Lyons LLP has several tax lawyers experienced in church tax issues and the parsonage exemption. Our lawyers can help churches properly document parsonage arrangements and are also well equipped to assist the clergy in meeting their tax challenges.
Jim Walker is RJ&L’s senior tax partner and a Fellow of the American College of Tax Counsel. He regularly represents taxpayers before federal and state administrative agencies, including the Internal Revenue Service, the Justice Department, and the Colorado Department of Revenue. He can be reached at 303-628-9510 or by email at jwalker@rothgerber.com.